Does anyone have any insight about this statement on ps 145 of CFAI volume 4 re: misfit risk. I am having trouble conceptualizing “A NON-ZERO MISFIT RISK IS ACTUALLY OPTIMAL BECAUSE A HIGH LEVEL OF “TRUE” RISK MAY MORE THAN COMPENSATE FOR A GIVEN LEVEL OF “MISFIT” RISK.” Also, maybe relate to a completeness fund that says the one drawback of a completeness fund is that they essentially seek to minimize misfit risk and this may not be optimal.
one of the ways you can generate alpha is to stray from the benchmark. So, a little bit of misfit risk is healthy to generate active return.
But you still have active risk to stray form the benchmark, no? I know active risk is related to the normal portfolio but it seems there still a degree of active risk even if misfit risk is totally eliminated.
Active is actual portfolio less your normal (ie style benchmark). The misfit is your normal/style benchmark less the broad market benchmark.
Misfits are normally benched. True, it’s totally normal. Misfits = normal - benched. True - total - normal. Easy way to remember this stuff.
HEYYYYYYYYYYYYYY!!! THATS MINE!!!
LOL. Credit to MGG.
It’s the risk you get in a car crash and encounter psychotic escaped convicts. She would of been a good woman if there had been someone there to shoot her for every minute of her life.
pimp Wrote: ------------------------------------------------------- > Misfits are normally benched. True, it’s totally > normal. Misfits = normal - benched. True - total > - normal. Easy way to remember this stuff. Just in case I didn’t get this right, is the following right? True Active Risk = Total Portfolio Risk - Normal Portfolio Risk Misfit Risk = Normal Portfolio Risk - Benchmark Risk Is that essentially it? Always struggle with misfit risk and still don’t fully understand the statement made by the original poster.
Yes - and Total Risk = SQRT((Misfit Risk^2) + (True Risk^2))
Correct PJ. As for the second part of the question that I/we don’t fully understand, I think at this point the conceptually quest is over and regurgitation of the statement will be easy.